When you embark on the search for a new home, you may think you know the steps to take: Read the listings, visit some open houses, sign on with a Realtor, make an offer. In fact, there's a biggie missing from that list — a step as important financially as the house you decide to buy itself: Get a mortgage.
It's widely understood that most houses and apartments are purchased using mortgage loans, which the Consumer Financial Protection Bureau defines as "an agreement between you and a lender the right to take your property if you fail to repay the money you've borrowed plus interest." Sounds serious — and it is. Mortgages come with a wide variety of lengths (called the term), repayment provisions and interest rates. Locking in the one that's best for you means getting something of an education. Especially if you're a first-time homebuyer, it pays to learn the ins-and-outs of mortgage financing so you'll know what to expect.
Mortgage 101
Before you even start to look for a mortgage, you'll want to understand how they work. The most common type of mortgage is what's called a 30-year fixed rate loan. As it sounds, you have three decades to pay the money back with the rate of interest that you lock in initially fixed for the entire time. You'll also see 15-year and sometimes 10-year fixed rate loans. These require you to pay off the home in a shorter period of time, but because the bank is lending the money for a shorter term, the risk that you won't repay the money is lower. That's the reason interest rates on shorter-term loans are lower than those on longer-term ones.
The other primary type of home loan is an adjustable rate mortgage or ARM. Here, the initial monthly payment is lower than prevailing interest rates (which allow buyers to qualify to borrow more money), but over time the rate adjusts in sync with current interest rates or another financial index. If rates rise, your monthly payment will rise (there's typically a cap that limits how far up it's allowed to go). If rates fall, your monthly payment may fall as well. Hybrid ARMs, which you may see represented as 5-1 or 7-1 ARMs, are fixed for the first 5 or 7 years before moving, for example, this can be a way to lower your monthly payments without taking on too much risk.
Qualify For The Best Rate On A Mortgage
Getting the best rate on a mortgage involves two things: shopping around (there are often significant interest rate differences among lenders) and your own credit. Before you begin shopping for a house, do your own homework to determine your creditworthiness and prepare for a conversation with a lender.
First, gather tax returns, pay stubs and other paperwork that documents your income for the past two years. You'll also need documentation of liquid assets, cash on hand, as well as credit history and your current income. That may include credit union, bank and investment account statements. If you're not familiar with your credit rating, request a free copy of your credit reports from the three major credit bureaus, Equifax, Experian and TransUnion and pull a free copy of your credit score. You may be able to do this through your credit union. If you find an error on your credit report, file an error report with the bureau in question on the bureau's website. They typically have a month or two to correct it.
What Lenders Are Looking For
As you gather information, keep in mind what lenders are looking for:
Better yet, sit down with a loan consultant at your credit union and talk through your specific situation. They may or may not be the lender you go with in the end, but it's a terrific first step toward getting an education (and credit unions are often very competitive when it comes to interest rates.)
Get Pre-Qualified (Then Pre-Approved) For A Mortgage
When you've found a lender with whom you feel comfortable, it's a good idea to get prequalified before you start shopping. Pre-qualification involves discussing the various loan program requirements and determining whether you will have the minimum down payment, employment and income history, credit history and payment reserves.
A lender shouldn't have to check your credit to pre-qualify you for a loan. In most cases, an underwriter (the loan professional who determines whether you qualify for a certain loan) will review the file and issue a conditional loan approval. The formal pre-approval process is the next step, where your loan application and credit report are submitted for review, along with income and asset documentation.
Understand The Real Costs
Once you've made an offer for a home and it's been accepted, you can move on to scheduling a closing date. Just keep in mind there are costs there as well. By law, all lenders must provide a good faith estimate of closing costs, but that list doesn't include all the charges you'll face. For instance, the title company, which researches the title or deed to the home to ensure that no one else has rights to it, will determine its own fees (for "title insurance") as will the home inspector, and a homeowners' association if applicable.
Don't Make Big Changes Before Closing
If you've gone through a loan pre-approval process, don't make any big changes — like switching jobs — until after your loan is closed. If you do, all the employment and salary data that your loan was based on is no longer accurate and you may no longer be approved.
And finally, if you don't qualify for a home loan right away, don't panic. There are things you can do to move the needle on your credit score. It won't happen overnight, but with hard work and diligence in paying your bills on time, every time, it can happen!
